With the release of Accounting Standards Update (ASU) 2018-18, the Financial Accounting Standards Board (FASB) clarified the interaction between Accounting Standards Codification (ASC) 808, Collaborative Arrangements, and ASC 606, Revenue from Contracts with Customers. Public entities must adopt ASU 2018-18 for fiscal years and interim periods beginning after December 15, 2019. All other entities must adopt the ASU for fiscal years beginning after December 15, 2020, and interim periods beginning in the following fiscal year. Early adoption is permitted if the entity has also adopted ASC 606.
Collaborative arrangements are contractual arrangements between two or more parties that involve a joint operating activity. Therefore, entities involved in a joint operating activity should first determine whether the activity qualifies as a collaborative arrangement as defined by ASC 808. If it does, the arrangement is accounted for in accordance with ASC 808. Revenue transactions under ASC 808 may or may not be within the scope of ASC 606 depending on whether the other party is a customer. This article will help entities determine if a joint operating activity is a collaborative arrangement and identify whether consideration exchanged between collaborators should be accounted for under ASC 606.
Collaborative Arrangement Criteria
A collaborative arrangement must involve a joint operating activity in which each party is an active participant and subject to both the risks and rewards contingent on the activity’s commercial success (ASC 808-10-20). A company must determine whether an arrangement qualifies as a collaborative arrangement at inception. If the participants’ roles or exposure to risks and rewards change, the arrangement must be reevaluated. The FASB provided the following examples of each characteristic of a collaborative arrangement, but these examples do not constitute an exclusive list and are meant only as guidelines due to the variety of collaborative arrangements in practice. Further clarification of what constitutes a collaborative arrangement can be found at ASC 808-10-15-7 to 15-13.
Joint Operating Activity
- Joint development and commercialization of intellectual property, a drug candidate, software, computer hardware, or a motion picture
- Joint operation of a facility, such as a hospital
- Directing and carrying out the activities of the arrangement
- Providing oversight, such as by participating on a steering committee
- Holding a legal right to the underlying intellectual property
Subject to Risks and Rewards
- Participants cannot exit the arrangement without incurring losses
- The financial participation of each party is significant to the endeavor as a whole
- The potential reward for each participant is not limited
Revenue from Collaborative Arrangements
In collaborative arrangements, participants frequently exchange consideration through profit sharing, expense reimbursement, and payment for services rendered. To be considered revenue within the scope of ASC 606, consideration exchanged in a collaborative arrangement must originate from a customer, which is defined as “a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration” (ASC 606-10-15-3). Entities should first determine whether the entire collaborative arrangement is a contract with a customer. For help identifying a vendor-customer relationship, see the RevenueHub article Definition of a Customer.
If the entire arrangement is not with a customer, but any part of the arrangement is potentially with a customer, entities should apply the distinct good or service (unit of account) guidance from ASC 606 to determine whether any units of account are with a customer. If goods or services must be bundled to meet the unit-of-account guidance, the entire bundle is not within the scope of ASC 606 unless all goods or services within the bundle are with a customer (ASC 808-10-15-5B). For help determining whether a good or service is distinct, see the RevenueHub article Distinct Within the Context of the Contract.
All parts of an arrangement that are not with a customer or do not meet the unit-of-account guidance in ASC 606 should be accounted for by another Topic, or, if outside the scope of any other Topic, by analogy to either ASC 606 or another Topic. If there is no appropriate analogy, the company should apply a rational and consistent accounting policy election (ASC 808-10-45-3).
Presentation of Collaboration Revenue
Consideration received from a non-customer (“collaboration revenue”) is not within the scope of ASC 606. Therefore, any collaboration revenue must be presented separately from revenue from contracts with customers on an entity’s financial statements.
Illustrative Collaborative Arrangement Case Study
The following case study below will answer the following questions:
- Does the arrangement between Developer and Aero qualify as a collaborative arrangement according to ASC 808?
- Is the entire arrangement with a customer?
- If not, which distinct goods or services (or bundle of distinct goods or services) are with a customer?
- How should Developer account for consideration within the collaborative arrangement?
Developer, an engineering firm, enters into an arrangement with Aero, a distributor of aerospace equipment, to jointly develop, manufacture, and commercialize a new aerospace control system.
- Throughout the project, Developer and Aero will have equal representation on a steering committee.
- Aero will pay Developer a non-refundable, upfront fee of $15 million for research and development (R&D) activities.
- If Developer creates a viable design for the control system, Developer will issue the patent to Aero in exchange for $10 million.
- Developer will then begin manufacturing the control systems while Aero manages all other commercialization efforts. Although Developer typically manufactures only on a small scale—such as for prototyping—Aero has requested that Developer initially manufacture the control systems until demand for the product is established.
- At the beginning of each quarter, Aero will make payments to Developer such that all revenues and costs from the preceding quarter related to manufacturing and selling the control systems are shared equally.
Part 1: Collaborative Arrangement Criteria
Collaborative Arrangement Criteria
The arrangement between Developer and Aero is within the scope of ASC 808 because it meets all three conditions stated above: (1) the arrangement involves a joint operating activity in the form of developing, manufacturing, and commercializing a new control system; (2) both companies are active participants by way of the steering committee and other responsibilities throughout the life of the project; and (3) both companies are exposed to risks and rewards dependent on the commercial success of the joint operating activity because Developer and Aero share equally in both profits and losses upon commercialization of the control system.
Part 2: With a Customer?
With a Customer?
In its arrangement with Aero, Developer has promised to: (1) conduct R&D services, (2) sell the resulting patent to Aero, and (3) manufacture the control system for commercialization.
To determine if the entire arrangement is within the scope of ASC 606, Developer first determines whether all obligations—distinct or not—are an output of its ordinary activities and completed in exchange for consideration. Although Developer clearly receives consideration for each of these goods or services, it is not clear whether they are all an output of Developer’s ordinary activities. R&D is a core component of Developer’s business and is thus part of Developer’s ordinary activities. Likewise, Developer routinely develops patents that it then sells or licenses. Manufacturing services, however, are typically performed by Developer only on a small scale, such as for prototyping. This project will require significant investment in additional manufacturing equipment and, therefore, is likely not part of Developer’s ordinary activities. Therefore, the entire arrangement is not with a customer.
Part 3: Applying The Distinct Good or Service Guidance
Applying The Distinct Good or Service Guidance
Part 2 demonstrated that Developer’s obligations to provide R&D services and sell the resulting patent are part of its ordinary activities and, therefore, potentially with a customer. Because part of the arrangement is potentially with a customer, Developer must now apply the distinct good or service guidance to determine which parts of its arrangement with Aero should be accounted for under ASC 606. If the manufacturing services—which are not with a customer—are not distinct, any other good or service that must be bundled with the manufacturing services to form a distinct bundle of goods or services is also excluded from ASC 606.
Developer concludes that the R&D services and patent are distinct from the manufacturing services because Aero, as the customer, receives a benefit from the R&D services in the form of the patent, which it can then purchase. This benefit occurs regardless of whether Aero receives the output of Developer’s manufacturing services—i.e., once Aero has the patent, it could hire a manufacturer other than Developer to manufacture the control systems.
Now, consider if Developer was not required to sell or license the patent to Aero. In this case, Aero relies on Developer to both develop and manufacture the control systems before receiving any benefit. Developer would therefore conclude that the R&D services, patent, and manufacturing services are not distinct and must be combined into a bundle to meet the unit-of-account guidance in ASC 606. This entire bundle would then be excluded from ASC 606 because part of the bundle (i.e., the manufacturing services) is not with a customer.
Part 4: Accounting for Consideration Exchanged
Accounting for Consideration Exchanged
Developer receives consideration from Aero for (1) R&D services, (2) the control system patent, and (3) revenue and cost sharing in the form of quarterly payments.
R&D Services. Developer should account for consideration received for R&D services in accordance with ASC 606 because Aero is considered a customer in the context of Developer’s R&D services.
Control System Patent. In conjunction with R&D services, Developer routinely generates new IP that it then sells or licenses to customers. Therefore, Developer should account for the sale of the control system patent according to ASC 606 because the sale of the patent is with a customer.
Quarterly Payments. At the end of each quarter, Developer records a receivable from Aero for revenue- and cost-sharing purposes. This type of consideration is not within the scope of any Topic, nor does any Topic apply by analogy; therefore, Developer should apply an accounting policy election to evaluate each part of the receivable based on the nature of the associated activity. For example, the portion of the receivable related to Developer’s share of revenue would be treated as an increase to collaboration revenue, whereas the portion of the receivable reimbursing Developer would be a reduction of cost of sales.
Developer’s collaboration revenue and its associated cost of sales should be presented on a net basis because, under ASC 606, Developer is considered an agent in the sale of control systems to third parties. See also the RevenueHub article Principal/Agent Considerations. Furthermore, Developer can apply ASC 606 only by analogy because Aero is not a customer in the context of Developer’s manufacturing services. Because ASC 606 is applied by analogy, net collaboration revenue must be presented separately from revenue from contracts with customers.
Although ASC 808 does not contain its own measurement or recognition guidance, the FASB provided clarification in ASU 2018-18 that will increase the consistency in which ASC 606 is applied to transactions in collaborative arrangements. In applying ASC 606 to collaborative arrangements, the major consideration is whether the counterparty to a transaction is a customer—either for the entire arrangement or for a distinct good or service or distinct bundle of goods or services. If the counterparty is a customer, the transaction can be accounted for according to ASC 606.
- ASC 606-10-55-36 to 55-40
- ASU 2018-18: “Collaborative Arrangements (Topic 808).” BC12-BC30.
- Deloitte, Heads Up: “FASB Amends Guidance on Collaborative Arrangements.” 13 November 2018.
- EY, To the Point: “FASB clarifies the guidance on collaborative arrangements.” 6 November 2018.