April 11, 2008
The FASB’s Emerging Issues Task Force recently issued new guidance for entities that enter into collaborative arrangements. Entities sometimes enter into these arrangements to participate in a joint operating activity that may involve the joint development and commercialization of intellectual property, such as a drug candidate, motion pictures or software. However, these arrangements are not limited to specific industries or to arrangements that involve intellectual property. For example, an arrangement may involve the activities of a jointly operated facility, such as a hospital.
More specifically, EITF Issue 07-1, Accounting for Collaborative Arrangements, defines a collaborative arrangement and establishes presentation and disclosure requirements for transactions among participants in a collaborative arrangement and between participants in the arrangement and third parties. This Issue does not address recognition or measurement matters related to collaborative arrangements.
Definition
EITF Issue 07-1 defines a collaborative arrangement as a contractual arrangement that involves two or more parties that both:
- Actively participate in a joint operating activity
- Are exposed to significant risks and rewards that depend on the commercial success of the joint operating activity
EITF Issue 07-1 applies to collaborative arrangements that are not primarily conducted through a separate legal entity, although a legal entity may be used for a specific activity in the arrangement or for a specific geographic area. The portion of the collaborative arrangement conducted through a separate legal entity should be accounted for under other existing generally accepted accounting principles.
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Active participation
According to EITF Issue 07-1, the following activities, among others, may comprise evidence of active participation in an arrangement:
- Participating in the governance and oversight of the arrangement, such as serving on a steering committee
- Directing and carrying out the activities of the joint operating activity
- Holding a contractual or other legal right to the underlying intellectual property
A party that only provides financial resources to an arrangement is generally not considered an active participant.
Significant risks and rewards
Contractual terms and conditions that could indicate a participant is not exposed to significant risks and rewards include, but are not limited to, the following:
- Services are performed for fees at the prevailing market rate
- A participant can exit the arrangement without cause and recover a significant portion of its economic participation to date
- Initial profits are allocated only to one participant
- The reward that accrues to a participant is limited
The evaluation of a participant’s exposure to risks and rewards should consider the expected duration or extent of a party’s financial participation in the arrangement in relation to the total expected life or total expected value of the arrangement.
Presentation and disclosure
Transactions with third parties
A participant in a collaborative arrangement must report the costs incurred and revenues generated on sales to third parties at gross or net amounts, depending on whether the participant is the principal or the agent in the transaction, pursuant to EITF Issue 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent. Accordingly, the participant deemed to be the principal for a particular transaction should report that transaction on a gross basis in its income statement.
The equity method of accounting should not be applied to a collaborative arrangement that falls within the scope of this issue.
Payments between participants
The income statement presentation of payments between participants pursuant to a collaborative agreement should be based on an evaluation of the relevant facts and circumstances, including the nature and contractual terms of the arrangement, the nature of the participant’s operations and the provisions of other authoritative accounting literature on income statement presentation.
If the payments are within the scope of other authoritative accounting literature, the participant must apply the relevant provisions of that literature. If not, the participant should base its income statement classification on an analogy to authoritative literature. If there is no appropriate analogy, the participant should then base its income statement presentation of the payment on a reasonable, rational and consistently applied accounting policy.
Disclosures
EITF Issue 07-1 also requires a participant to a collaborative arrangement to make certain disclosures.
Effective date and transition
EITF Issue 07-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and for interim periods within those years. It should be applied retrospectively to all periods presented in the financial statements for all collaborative arrangements existing as of the effective date, unless impracticable.
Take note
The consensus of EITF Issue 07-1 could have a significant effect on a not-for-profit health care organization that has historically reported the results of its participation in a joint operating agreement using the equity method of accounting in accordance with AICPA Technical Practice Aid 6400.33, Health Care Organizations: Accounting for a Joint Operating Agreement. EITF Issue 07-1 prohibits the use of the equity method of accounting for a collaborative arrangement that falls within its scope. Therefore, the guidance in TPA 6400.33 on using equity method accounting for certain joint operating agreements will no longer apply to agreements that are in the scope of EITF Issue 07-1.