Pharma accounting: the key IFRS issues

Why is pharma accounting different?

The value of a pharmaceutical company lies mostly in intangible assets it often cannot recognise: the knowledge in its pipeline and the patents on its products. Spending on them is expensed, while the same assets bought from others are capitalised. Revenue comes not only from selling medicines but from licensing rights to others, sharing development with partners and royalties. And selling prices are reduced by rebates and discounts that are only known months later.

Which IFRS issues matter most in pharma accounting?

When is research and development capitalised?

Research is always expensed. Development is capitalised only when all the IAS 38 criteria are met, including technical feasibility, which for a new medicine is usually not demonstrable until regulatory approval is obtained or highly likely. In practice, innovator companies expense almost all clinical development, while generics companies may capitalise from an earlier point. See when pharma capitalises R&D.

How are licensing deals accounted for?

A company that out-licenses a drug candidate decides whether the licence is a right to use its intellectual property as it exists, recognised at a point in time, or a right to access it as it changes, recognised over time, and whether it is distinct from any research services it also provides. Development and regulatory milestones are variable consideration, included only when highly probable not to reverse, often not until the milestone is achieved. Sales-based royalties and sales milestones are recognised only when the sales happen. See IFRS 15 licences.

How are rebates and chargebacks handled?

Gross list prices are reduced by government and insurer rebates, wholesaler chargebacks, discounts and returns. Each is variable consideration estimated when the product is sold, so revenue is recognised net, with a liability for amounts to be paid. In some markets, these deductions exceed half of gross sales, so the estimates are among the most important in the accounts. See variable consideration.

How is acquired in-process R&D treated?

A drug candidate bought separately or in a business combination is capitalised as an intangible asset, because the price paid reflects the probability of success. It is not amortised until the drug is available for use, but it is tested for impairment every year. Under US GAAP, in-process R&D bought in an asset acquisition is expensed unless it has an alternative future use, a significant difference from IFRS. See IAS 38 intangibles.

What happens when a trial fails?

A failed or halted trial, a regulatory rejection or a competitor's better data are impairment indicators for capitalised IPR&D and licence assets. The impairment is often the whole carrying amount, because the asset's only value was the chance of success. See IAS 36 impairment.

What other issues arise?

Collaborations, where partners share development costs and profits, require a decision on whether the partner is a customer. Inventory produced before approval is capitalised by some companies when approval is probable. Contract research organisations recognise revenue over time as they perform trials for sponsors. More detail is in the guides on licensing deals and milestones, sales-based royalties, rebates and chargebacks, acquired in-process R&D and impairment after trial failures. Government funding for research is covered in government funding for drug development, and claims over products in product liability provisions.

This guide is general information. It is not tax or legal advice for your situation.